Tuesday, August 6, 2013

Election 2013: Day 2 (or, you could cut the interest rate with a knife)

Unfortunately tonight’s post will just be a short one, because I spent the day firstly finishing up my Drum post for tomorrow, and then the afternoon doing a live-blog for The Guardian on the interest rate decision.

The politics is interesting because when you are a party that for nigh on 10 years has been banging away about how “interest rates will always be lower under a…” and you suddenly find that interest rates are now much lower than they were under your government, well you need to come up with a new line.

And so now it is “the economy will always be stronger under a Liberal Government”. This of course is patent bullshit for anyone old enough to remember life under the Fraser-Howard Government when both unemployment and inflation achieved the dubious achievement of being over 10% at the same time. We’ll also ignore that in March 2012 for the first time in over 40 years, GDP growth was over 3.5%, unemployment was under 5.5% and inflation was under 2.5%

Look if people want to indulge in pathetic “blah blah will always be blah blah under a blah Government” go ahead. But cripes, that doesn’t mean we have to swallow it.

So the interest rate cut dominated the day. It was the first time since the RBA has been independent that interest rates have been cut during an election campaign, and one of the great things about the cut is no one was suggesting it was a political cut.

But there was a lot of politics related to it.

Joe Hockey put forward his thesis that the RBA is only cutting rates because the economy is n bad shape. And look that’s fair enough – the RBA does cut rates when it needs to give the economy a shove. The key thing is to keep interest rate low when the economy is going strong. So in effect – looking at the average of rates “over the cycle”

Hockey on AM this morning answered this way in response to the question of low rates under this government:

JOE HOCKEY: Well on average the interest rates have been lower under the Coalition, if you look at the Coalition electoral cycle, it was, the average standard variable mortgage rate was 7.26 per cent. Under Labor it's been 7.29 per cent. Small business, unsecured overdraft rate under us was 8.89 per cent, under Labor it's been 10.08 per cent.

Now c’mon, really Joe. You’re arguing that 7.26% to 7.29% is a wining argument? You do know that 0.03% is about a $5.80 difference per month in interest rate payments for a $300,00 loan?

That’s your big proof of better economic management?

Ok. I guess then you won’t mind if we take into account the fact that given all the banks are passing on the full rate cut, and that if we include this month, the average of mortgages under the ALP term of government will be 7.27%.

Will you still claim the $1.94 a month saving as proof the Libs know better how to run the economy?

How about if we include September (because any rate cut in September will occur before the election, so the ALP gets credit for that as well) and we suddenly find that the average under the ALP government since December 2007 is now 7.26%.

Hey look, take heart, a draw is still not a loss! (except of course if you’re playing the Ashes… cursed rain)

Hockey is right about the difference in rates for small business. But that has nothing to do with the ALP – unless Hockey thinks the ALP is to blame for the GFC (which, for all I know he does – it would make an improvement on most of his fellow LNP members who seem to have forgotten there was a GFC at all).

After the GFC, banks fled to safety. Risky loans were suddenly seen as too risky, and importantly risk carried with it a premium that it hadn’t had for any of the 2002-2007 years.

Small business loans are risky – at least riskier than a mortgage – and thus their rates have stayed relatively higher than have mortgage rates.

I’ve been noting this for a while with this graph:

Now Joe Hockey also in the press conference after the announcement sought to pooh pooh the cash rate by pointing out that the ALP’s low interest rate guff didn’t count because the spread (or gap) of the cash rate to the mortgage rate and business loan rates had grown since November 2007.

This is quite true, as indeed I have also noted many times before on this blog with this graph:

So it looks like case closed for Joe.

The problem is this is more a case of a little bit of knowledge being dangerous.

People might not borrow at the cash rate, but significantly the cash rate isn’t the only way banks borrow (or “raise) money.

If we look at the way bank raise funds we see that it changed rather drastically around the start of 2008 (exactly the same time that "spread in the above graph started going up).

And it wasn’t because of a Labor Government, it was because the raising of funds with the cheap “short term debt” from overseas suddenly started to get expensive.

Prior to the end of 2007 banks used to get about 30% of their funds on the cheap from overseas (funds they used to then loan out to you and to businesses at a profit).

Now they get less than 20% of their funds this way.

Prior to 2008, domestic deposits (ie you and I and grandma putting our money either in a savings account or better still a “term deposit’”) had been declining in importance for banks. It was still the most important but it accounted for below 40% of all funds.

After the GFC, suddenly term deposits became like gold for banks – because they are safe – and when all the banks are after the same thing – you and I and grandma’s money – that means they need to pay more to get it (ie offer higher interest rates for deposits).

And thus not only did the importance of domestic deposits go up, so did the cost to the banks of such deposits.

So let’s look at the spread of the cash rate to term deposits:

Do you notice anything about the spread between 2003 and 2008?

Yep it was negative. The banks were giving you LESS interest for your deposits than they were paying with the cash rate! And this was for 40% of their funding! Talk about sweet deal!

See what happened when the GFC hit? Yep – boom. By 2010 the interest rate you could get for your term deposit was nearly 2.5 percentage points more than the cash rate.

Do you think that might have been a reason why banks suddenly weren’t able to pass on all the cuts in the cash rates?

And just to ram it home, let’s have a look at the cost of that overseas “short-term debt”. The best way is to look at the spread of the 3 month overnight index swaps to the 3 month bank bills. (That is basically nerdy, Banker-speak for the amount it cost banks to lend to each other over short period of time – the bigger the spread, the more it costs):

Again, notice how cheap and stable it all was from 2002 to 2007? Think the Howard Government had much to do with the rate banks were lending and borrowing from banks in American and Europe? Nope.

Now look at the situation while Labor have been in power. Calm is not the word. But GFC nuttiness is.

There is nothing the Govt can really do about this, but it explains why again the gap between the cash rate and your mortgage has increased. Banks went from being able to get around 30% of their funds at a nice cheap, stable rate, to suddenly it being a very scary and costly way to raise money.

And even though the rate is now back down, the RBA has a nice graph that shows how because of the average length of time such debt is held, it takes a while for the decrease in spread to flow through to the average cost of the banks’ funding.

Now I’ll leave you with one final graph.

It is a graph that looks at the spread between the average term deposit rate and the average mortgage rate.

In effect this is the difference between what the banks charge you to get money from them, and what they pay you to take your money.

If banks were screwing us, or if the ALP was useless at holding the banks to account and the Liberal Party could do much better, then you would think that the gap between the two would be quite s bit larger now than it was under Howard.

So what is the picture?

Well under the Howard Government – during period of amazing ease on the international banking market, where everyone thought cheap credit could last for ever – the average spread was 3.04. During the Rudd-Gillard Government, when the hangover of that lazy period of cheap credit sent shockwaves through the banking sector that were like 9.7 on the banking Richter scale, the average spread is 3.14.

At the moment though the spread is 2.9.

So I’ll give Hockey 0.1% point on average to brag about.

Slow hand clap.

But maybe, just maybe, it is time to stop comparing apples with apples. And maybe, just maybe it is time for those who would be our government to stop trying to tell us the lie that the GFC was just something that happened in the Northern Hemisphere and had no impact on Australia.

Anyhoo.

That’s my interest rate rant over.

***

While live-blogging today for three hours today, I very nearly went into head-explosion territory. It made me all the more respectful of the great work currently being done by those who live-blog daily politics.

Back in 2010 when I decided to do a daily post on the election I did so because nowhere was there a good close analysis of the days events (in my opinion). I thought a lot got missed in the “daily summaries”.

Well now, for all your political needs, the live blogs are a great place to go.

The first to really start the live-blogging of politics here in Oz, was Katharine Murphy with her “The Pulse blog” for Fairfax. She is now with The Guardian, and biased as I am because I work for it, she is still absolutely brilliant at it (except when I give her a bit of advice and it turns out to be wrong advice, as happened today – the moral being, shut up Greg, you’re in the way).

My ongoing theory about the Coalition's view of the GFC is: the reason they're alleging the ALP "mishandled" it is because according to their theories and policies, Australia was supposed to be going down the economic gurgler, just like everyone else. That way we'd be in the same relative position we'd always been, and we'd have the same economic challenges as every other economy, and we could have handled them in the same way every other economy did (i.e. badly). Instead, the ALP under Rudd decided to go against the flow, and instead of going into an economic tailspin for over five years, we've had an economy which actually performed pretty well against other economies globally. Which apparently isn't supposed to happen, according to the Coalition's economic thinkers.

So the ALP "mishandled" the GFC and are "poor economic managers" as a result... because they didn't steer the Australian economy over the same financial cliffs and into the same economic tarpit that the majority of the world is just starting to struggle out of.